One of life's abiding mysteries is the ongoing strength of the New Zealand dollar.

OPINION:
The whole idea of liquid markets is that they should deal quickly with mispriced assets, pushing them to a level that reflects their "true" value.

As one of the seven most traded currencies on the planet, you'd think that should mean the kiwi wouldn't remain perpetually over-valued. Yet it does.

Among the more respectable explanations: Firstly, strong demand for anything pushes its price up. The level of trading in the New Zealand dollar is a reflection at some basic level of demand. It's strong, so the exchange rate will be too.

Secondly, New Zealand interest rates are higher than just about anywhere else in the developed world, creating demand among investors seeking yield in an environment where the United States, European Union, and Japan have held rates at close to zero in the last four years.

Thirdly, the extraordinarily strong run of dairy prices until early this year, combined with strong inward migration and the stimulus created by Canterbury's rebuild, add up to one of the strongest economic growth stories among the the OECD.

This last factor has been the clincher. New Zealand has been on a tear compared to its traditional trading partners. However, much of the recovery story is either no longer true or is going off the boil.

The Chinese economy is going through a soft patch and its dairy commodity inventories are stuffed full at present. There's not much reason for dairy prices to recover strongly, although Westpac economists predicted this week that they might stabilise and improve by year's end.

The second leg of the story - New Zealand's strong domestic recovery - is also a bit more questionable as a reason for a high dollar. That's because it's occurring so far without much evidence of the expected burst of inflation that would justify ever higher interest rates.

Wage rates are barely moving, house-price inflation is waning faster than the Reserve Bank would have dared hope, and while there's pressure on construction costs in Christchurch and Auckland, they're not heading north as fast as feared.

The Reserve Bank has already signalled a pause for some months before it lifts the official cash rate again. ASB economists this week pushed their expectation out for the next OCR increase to March next year, instead of a more widely expected December rise.

Meanwhile, despite weak employment figures in Australia last week, there's nothing to suggest the Reserve Bank of Australia might cut rates across the Tasman, as Aussies pile back into consumer spending and bid up house prices again. Any fear New Zealand interest rates might become even more attractive than Australia's looks unfounded.

So that really only leaves the fact that New Zealand dollars are widely sought and traded in foreign exchange markets. That's ultimately a good thing for a small trading nation, but it's not enough on its own to keep the kiwi high.

Instead, it looks as if we're now on an inflexion point.

The kiwi has slipped further against the US dollar in the last month than 29 out of 31 currencies tracked by the Bloomberg financial information service, the Bank of New Zealand says.

"We can't hand on heart claim to have foreseen the very strong tailwinds that have accelerated the New Zealand dollar's slide south," wrote analyst Raiko Shareef. Dairy prices had fallen further than the BNZ expected and it was surprised by last month's monetary policy statement, in which Reserve Bank governor Graeme Wheeler invoked a rare intervention threat.

Even so, Wellington fund manager Harbour Asset Management says "the real surprise is the minor adjustment so far in the New Zealand dollar. Yes, the kiwi is down from a cyclical high of over US88 cents, but at just over US84c today the kiwi is still trading near the average for the past year and only 5 per cent off the high", says Harbour Asset.

"Even looking at global developments it is hard to see continued support for an exceptionally strong New Zealand dollar.

"The fundamentals for the New Zealand dollar have changed."

In other words, the correction we're seeing has so far been orderly. But history tells us to expect savage corrections after long periods of apparently irrational valuation.

It usually takes a circuit-breaking event to force that. Usually, it will be a global trigger, but it can also come from unexpected domestic shocks. While the polls don't suggest it's a likelihood, an unexpected change of government next month would greatly surprise financial markets and might well do the trick. BusinessDesk